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Chapter 19 Network economics and the information sector

1. The structure of costs and revenues in the information economy


2. Networks and their effects
3. The choice of standards
4. The cost structure of information industries
5. The implications of near-zero marginal costs
6. Price discrimination and profitability
7. “Versioning” and pricing information products
8. Switching costs and lock-in
9. The debate over ‘increasing returns’

The chapter examines the ‘network industries’. It outlines the idiosyncratic features
of their cost and revenue conditions, the implications of these conditions and the
debate over the ‘lock-in’ and increasing returns.

- The explosive development of the software industry, the information economy and
the Internet have led to suggestions that the ‘old’ rules of economic life have been
suspended at both macro- and microeconomic level.
- Macro-level, it argued that the productivity gains arising from the new technology
have changed the relationship between inflation, employment and output growth
- Economy  sustain high growth and high employment without triggering the
inflation
- Micro-level, the importance of revenues, costs and profits left behind as Internet
firms never made a profit in 1999 but were given billion dollar valuations
- Neither of these developments justifies the assertion that the established rules of
economic life have been suspended

1. The structure of costs and revenues in the information economy


- Profit maximization assumption
- Profit is the difference between revenue and cost
- Revenue  depends on demand conditions
- Cost  depends on the technological conditions of production
- Consider how information technology and impact of internet affect those
determinants of the firm’s performance
- Two major phenomena 
- Network effects, which have an important impact on the demand for firms’ output
- Sunk cost, which affect the way in which cost per unit is related to the firms’ level
of output
- Both related to the boarder issue of increasing returns

2. Networks and their effects


- A network may be defined as a set of ‘nodes’ connected by ‘links’
- In economics the nodes are economic actors (firms or individuals)
- The links may be roads, railway lines, copper cable ….

- Important economic characteristics:


- First, there is a high degree of complementarity among the different components
- E-mail message  computers, servers, software and connecting cables are all in
place
- Networks may be either two-way or one-way
- Both types of network the nodes and the links between them must be compatible
with each other and it is that compatibility that makes the complementarity
operational
- Single firm  internal coordination mechanisms
- Different organizations  other coordinating device such as industry standards

- The feature of networks means that the demand for the services it provides is
unusual in that the unit value of a network service increases as more people
consume it.
- Network effects arise because of the complementarity of the different components
required – servers and computers for instance

- A key question in respect of network effects concerns the way in which they relate
to network externalities
- A network externality arises if a decision-maker does not bear the full cost of the
actions they take in respect of a network
-